Investors have long seen the opportunity in purchasing a distressed residential property, quickly rehabbing the building, and then re-selling it for a profit. Indeed, the success many investors have enjoyed, coupled with the popularity of numerous television shows based on the subject, have turned “fix-and-flip” investing into nothing less than a national phenomenon.
But all that popularity and promise has led to an increasing level of competition for real estate investors. That competition has in turn forced investors to take on riskier fix-and-flip projects.
Investors who see this trend continuing in the near future should already be looking for other opportunities within the real estate marketplace. In fact, their next “fix” may not include a “flip” at all.
If you’re an investor who is no longer seeing the returns you expected from residential fix and flips – or if you’re simply looking to diversify your portfolio – now may be the time to consider a commercial fix-and-hold investment. In today’s market, investing in commercial real estate and adjusting your long-term goals could be the surest way to prevent your next flip from flopping.
Benefits of a commercial fix-and-hold strategy
Investors who are comfortable flipping residential homes in a matter of months may balk at the thought of owning commercial real estate – such as a private office, retail space, or apartment building – for a longer period of time. But commercial properties behave differently than their residential counterparts, and in many instances contain benefits that are worth taking advantage of for a longer period of time.
First, consider the passive income you can generate by collecting multiple rents. An investor who goes through all the work of rehabbing a 5-unit apartment building and then quickly re-sells the property misses out on the opportunity to collect five rent checks from tenants each month.
This way, you can continue to hunt for lucrative fix-and-flip investment opportunities while enjoying a steady revenue stream.
By foregoing the “flip” aspect of your investment strategy, you are also able to build equity in the property. Having the ability to refinance and gain access to that cash can be very valuable if you plan on making another investment down the line.
Sure, a traditional fix-and-flip gives you the opportunity to turn a profit in a shorter amount of time. But holding onto a commercial real estate investment and creating an additional revenue stream can be a savvy diversification tactic if you are looking to guard against short-term flops in 2018. Here are a few tactics to employ as you consider a commercial investment:
1. Do your homework
If you’re considering a commercial real estate investment, the first step is to understand what exactly this type of investment entails. Commercial and residential properties are significantly different in a number of key ways. If you have only ever invested in residential real estate, you will likely not be prepared to jump into the commercial arena unless you conduct your due diligence beforehand.
One of the primary differences between homes and commercial properties is the fact that every commercial property is unique. While each home within a neighborhood may be quite similar in structure and value, a particular city block may be comprised of offices, retail shops, restaurants, and apartment buildings.
If you’re unfamiliar with commercial real estate properties, it may make sense to set your initial focus on commercial multifamily properties. These are simply apartment buildings with five or more units, so you have more of an opportunity to leverage existing knowledge if you have flipped residential properties in the past.
A fix-and-hold strategy makes sense with these types of multifamily properties. While you may see more value in flipping a single family home as opposed to collecting a single rent each month, the equation can look quite different when the number of rents jumps to ten, for instance.
Conducting a healthy amount of research is a crucial step for any investment, and a commercial real estate investment is certainly no different. But if you focus on properties that resemble the investments you’ve made previously, then the learning curve will likely be less of a hurdle.
2. Start small
News headlines involving multi-million dollar commercial developments promote the misconception that commercial real estate investing is a game only the wealthy and connected can play.
But the truth is that you do not need to be a real estate tycoon to find success. In fact, many of the success stories involving commercial real estate investments are happening on Main Street, not Wall Street. Setting your sights on the more attainable fix-and-hold opportunities in your area can expose you to more opportunities and give you a greater chance of successfully hitting your investment goals on schedule.
Examples of Main Street commercial investment opportunities include the types of small apartment buildings mentioned earlier, as well as the variety of private offices and mixed-use properties you drive past every day.
An important part of any rehab project is determining which improvements you can carry out yourself and which projects need professional assistance. You can maximize your profit margins by investing in a smaller property that requires less rehab.
Stabilizing a real estate asset is no easy feat in any circumstance. One way to make the process unnecessarily difficult is to bite off more than you can chew.
3. Take time to master the lending environment
Securing a mortgage loan for your commercial investment is a crucial step in the process, and one that could cause a “flop” before you even make the initial purchase. That is because banks and other traditional types of lenders often make it difficult for investors to secure financing.
Veteran fix-and-flippers have likely already experienced issues with traditional lenders, with one of the most common being transaction length. Real estate investment opportunities come and go in a flash, so delays or hiccups that occur during the approval process can be devastating for investors who only have a short window during which to purchase a property.
When you add the fact that banks are less likely to lend on properties that need extensive rehab, it becomes clear that alternative solutions are often needed for commercial real estate investments.
Fortunately, a number of non-bank alternatives exist in today’s market. Hard money lenders and other private lending solutions will typically offer a higher interest rate than their bank counterparts, but they also provide additional flexibility and are able to close loans in days or weeks, not months.
Alternative lending options are also helpful for real estate investors who are unable (or unwilling) to provide the extensive amount of documentation most banks require. If you’re self-employed and find it difficult to provide tax returns when applying for bank loans, a reduced documentation loan from an alternative lender could make all the difference.
4. Determine the financing option that suits your goals
Transitional financing solutions are key during the “fix” step of the process, regardless of whether you plan to flip or hold onto the property in the future. When it comes to commercial-fix-and-holds, many investors opt for a bridge loan.
Securing a bridge loan gives you access to short-term financing at a slightly higher interest rate. Once you complete the rehab or stabilization process, you can leverage your repositioned asset and refinance with a more attractive, long-term loan.
Many different types of lenders offer bridge loans – the best solution for you will depend on your investment goals, credit history, and timeline.
5. Learn how to increase your property’s value
The value of residential properties is mainly determined by comps in the area. This means that fix and flippers who make substantial upgrades to their investment property won’t automatically see the value of the home increase.
On the other hand, commercial properties have far fewer comps and are instead valued by the income they generate. If you understand capitalization, or “cap” rates, and can identify ways to increase revenue, you can have a much greater impact on the value of your commercial property.
The cap rate of a commercial property can be found by dividing the Net Operating Income (NOI) of the building by its value. In a basic sense, a cap rate reveals the percentage return one can expect to make after purchasing a property.
If you improve the NOI of the property you purchased, either by adding tenants, reducing property management costs, increasing rents, or by any other means, you can increase the cap rate and make the property more attractive as you seek long-term financing solutions.
While one could take a much deeper dive into subjects like cap rates and NOI, it’s clear here that you have an opportunity to guard against “flops” by gaining a better understanding of the various ways you can affect the value of the investment property.
6. Have an exit strategy
Do you have a clear idea of what exactly you will do with the property once all improvements have been made? And do you have a contingency plan to cover any extenuating circumstances? Without these in place, you can put your investment in great risk – especially if you are planning to tap into your commercial property’s equity to make another residential investment.
But an exit strategy isn’t just important for your sake. Lenders will also want to understand your exit strategy before they finance your property. If they are not satisfied with your plan, they will ultimately lose confidence in your ability to repay the loan.
The key to creating a winning exit strategy is to ask yourself some key questions:
• How long do you plan to hold onto the property?
• Do you have a reasonable date in mind for when all rehab will be completed?
• Do you have the resources necessary to ensure all projects stay on schedule throughout the process?
• Do you have a clear strategy for marketing the property to prospective renters?
The more answers you can provide for questions like these, the more confident you can feel about the success of your fix-and-hold investment.
Investing in commercial real estate does have its challenges. But residential fix-and-flip investors should weigh these complexities against the opportunity they have to diversify their portfolio and establish a new passive income stream.
If you’re looking at an office, warehouse, multifamily, or retail property as a potential investment opportunity, be sure to follow the tactics listed here. While there is no one strategy that can guarantee success, doing your homework and making informed decisions will put yourself in a much better position to avoid “flops” and achieve your investment goals.
Author Bio: Leslie Smith is Managing Director of Commercial Direct. She led the launch of Silver Hill Funding in 2016, and is building on that experience to spearhead the launch of the consumer-facing direct lender, Commercial Direct.
An experienced financial services professional with more than 20 years in the industry, she has been instrumental in leading multiple initiatives that expanded companies into international markets, as well as developing systems and programs to drive operational productivity and efficiency. Leslie is a 10-year veteran of Bayview Asset Management, the parent company of Silver Hill Funding and Commercial Direct. She previously held the roles of Senior Vice President, Operations and First Vice President, Operations. During her tenure at Bayview, she led multiple divisions and initiatives in project management, banker education, systems administrator, correspondent lending and process engineering.
Leslie holds a B.A. in International Relations from Florida International University and an MBA from Nova Southeastern University. She lives in Coral Gables, Florida with her husband and twin daughters.
Learn more at www.commercialdirect.com.